Thanks to the large group of delegates from Colombia and Chile who attended my FTP workshop in Santiago. Once more, I observed that bankers in Central and South America are much more aware of the necessity for FTP for effective risk and earnings management; unlike many of their counterparts in the US and Europe, they recognize that interest rate risk and liquidity risk are material drivers of earnings.

Because these countries have more volatile interest rates and liquidity spreads, the necessity for FTP is undeniable; if risk-related earnings are mis-attributed to lending and deposit products, business strategies and capital allocation may not be just sub-optimal, they may be fatal.

Despite the awareness though, most participants noted the ever-present challenge of getting management to acknowledge the necessity of computing economically-robust measures of product profitability which correctly reflect contemporaneous hedging costs. At many of their organizations, it is not unusual for FTP rates to be manipulated to make products appear profitable or to force mismatch center earnings to be zero (to be fair, such practices are common around the world at banks and credit unions of all sizes). While it’s one thing to understand that FTP is necessary; it’s another thing entirely to understand how FTP rates must be computed for spreads be meaningful.

In the workshop, we referred to the difference between management by TRUTH and management by FICTION. Regulators and board members would be wise to ensure that risk and profitability management policies compel management to employ methodologies which have economic integrity.

We also discussed risk and profitability measures which require explicit behavioral assumptions around NMDs. I then presented my approach for quantifying deposit behaviors which ensures that key risk and profitability management measures are fed with a common set of behavioral assumptions; this is accomplished by an FTP rate calculator which is integrated directly into the behavioral model. FTP rates are computed using the same re-pricing and liquidity cash flows which are used to feed the ALM model, and in addition to providing historical and pro forma FTP rates for each product, any behavioral changes which result in model re-calibration produce a logically consistent change in FTP rates and FTP rate dynamics.

Thanks again to the entire group and translators who made this workshop a huge success. It is always an honor to be invited to another country to share my views on this fascinating subject.

Thanks to everyone from Colombia and Dominican Republic who attended my deposit modeling workshop in Bogota. In addition to experiencing higher and more volatile interest rates relative to banks in the US and Europe, the introduction of non-bank financial intermediaries and on-line banking platforms which facilitate costless balance transfers between institutions are challenging the historical stickiness of deposits in these countries. As a result, the assessment of interest rate risk, liquidity risk and product profitability must be revised to acknowledge the decreasing value of NMDs.

In the workshop, we discussed numerous risk and profitability measures which require explicit behavioral assumptions around NMDs. I then presented my approach for quantifying deposit behaviors which ensures that key risk and profitability management measures are fed with a common set of behavioral assumptions; this is accomplished by an FTP rate calculator which is integrated directly into the behavioral model. FTP rates are computed using the same re-pricing and liquidity cash flows which are used to feed the ALM model, and in addition to providing historical and pro forma FTP rates for each product, any behavioral changes which result in model re-calibration produce a logically consistent change in FTP rates and FTP rate dynamics.

In the workshop, we also discussed several high-profile banks in the US whose earnings have been punished by rising rates because of their over-reliance on high-rate, volatile money market accounts. These institutions evidence a complete failure to understand the relative value of different types of deposit products and almost certainly a failure to acknowledge how IRR and LR contribute to overall corporate earnings. In short, above-market asset growth is not a viable strategy for long-term, stable earnings growth. Almost certainly these firms do not utilize FTP to determine earnings attributions. When deposits are simply assumed to be profitable, a painful reckoning is inevitable.